How to Avoid Fraudulent Schemes in a Frothy Market

by Hilary Kramer | June 2, 2013 8:00 am

How to Avoid Fraudulent Schemes in a Frothy Market

Right now, we’re in a very frothy market. The Street has hit high after high, and investors have been raking in the big bucks. But when I see markets like these, I get a little nervous. It’s a great time to grow your wealth, but now is also the time when greedy “professionals” are going to come out of the woodwork and take advantage of the investors wanting guidance to make some extra income. They promise big returns and then take these poor victims for everything they’ve got.

I don’t want you to fall into the same traps, so I’ve pulled together a list of the most common investment scams and the red flags you should look for in order to avoid them. Let’s take a look.

Ponzi Scheme: This type of investment fraud is the most notorious. It is a fraudulent operation that pays investors from their own money or money paid by new clients. Bernie Madoff pulled off the biggest Ponzi scheme in history, defrauding his clients of almost $65 billion.

Pyramid Scheme: Current investors recruit new members, but the people at the top benefit far more than those at the bottom. Eventually, the money well goes dry and the scheme falls apart.

Advance Fee Fraud: An upfront fee (usually a large amount) that is required to have access to a “fantastic investment opportunity.” But in reality, the investment doesn’t exist.

The Pump and Dump: This scheme is as dirty as it sounds. A small group of investors buy a stock (usually with a small or illiquid share float that is easy to manipulate). The stock is then hyped to the moon to thousands of investors, which causes the price to spike. The group then sells their stock and leaves the duped investors holding the bag.

Prime Bank Scheme: Scam artists lead investors to believe that they can make high returns by participating in a secret trading regime, typically with the world’s major banks. (This is how the retired police officer was defrauded).

Here are a few red flags that you should always look out for:

Guarantees: If someone guarantees that an investment will perform a certain way, ignore them. All investments carry at least some degree of risk.

Overly Consistent Returns: Any investment that constantly moved up month after month, especially in a volatile market, is cause for concern.

Complex Strategies: Walk away from a person who credits a highly complex investing technique for unusual success and can’t explain (in full detail) how their process worked. An investment professional should always be able to explain, step by step, how you were able to make a return on an investment.

Missing Documentation: If someone tries to sell you an investment without the proper documentation, it’s a sign that the person could be selling unregistered securities. They should always be able to provide documentation. No papers? No deal.

Account Discrepancies: Yes, people can make genuine mistakes, resulting in an error. Or, this could be an indication of fraud. Always keep a close eye on your accounts. And if you ever notice even the smallest discrepancy in numbers, contact your adviser immediately.

A Pushy Salesman: If someone pressures you to decide on a stock sale or purchase, stay away. No investment professional should ever try to force a sale on you, and even if what they are pushing is not illegal, it is completely inappropriate.

VIP Access: When a person makes you feel privileged for receiving an invitation to join the “elite club.” This is exactly what Madoff did. He would give only one out of three potential investors the opportunity to invest.

I will never tolerate dishonesty. The idea that someone’s greed can cost another person their life’s savings is unfathomable. But not everyone feels this way, which is why so many people end up defrauded. So to keep yourself out of harm’s way, and to stay profitable, watch out for those red flags, and find an adviser you can trust with a good track record. You’ll set yourself up to do better financially, and you’ll be able to sleep better at night.